DSCR what it is and why it matters

DSCR is the Debt Service Cover Ratio required by bankers… typically when they are ‘cash’ lending for an MBO, acquisition etc

They want to make sure a company’s annual Cash Flow can cover its annual Debt repayments… and they add a little bit on for comfort

So… let’s play numbers

If a company has £100k Debt repayments (including interest)

And their Bankers apply a DSCR of 1.3

Then the company must have CFADS (Cash Flow Available for Debt Service) of £130k to keep their Bankers happy

In the Real World

The calculation is done the other way round… so

Say our company has CFADS of £500k

And their Banker’s DSCR of 1.25

Then the company has a Debt repayment capacity of £400k

The Bank will then deduct any existing Debt repayments (Funding Circle loan, HP payments) … say e.g. of £100k

The Bank now thinks the company can cope with an extra £300k of Debt repayment each year…

For an MBO they may typically lend over 3 to 4 years… meaning our company can borrow an extra £900k to £1.2m

CFADS

Obviously DSCR is just about symbiotically linked to CFADS… so check out the post and video on CFADS here

 

CFADS how to calculate it and why it matters… and it does

CFADS is a measure of a company’s Cash Flow Available for Debt Servicing… and it matters because Bankers like it… so if you’re looking at an MBO or going on an acquisition spree chances are your bankers will look at your CFADS to see if they want to come along…

Calculating your CFADS… and how much they’ll lend you

Here’s a video working through the nuts and bolts of calculating your CFADS & what a bank’ll lend… and if you want a spreadsheet to help you out drop me a line at pete@pete-wild.co.uk

Essentially Banks :

1.Caluclate your CFADS

2.Adjust for their required DSCR (Debts Service Cover Ratio)

3.Deduct any existing Debt repayments you’re making

4.Multiply the result by 3 or 4

And that tells them what they can afford to lend based on the company’s ability to generate enough cash to pay them back

In the Real World

What if your CFADS won’t get you the cash you need?

All may not be lost if your CFADS doesn’t quite support the money you’re looking to borrow…

… in the real world the banks are often trying to work to a figure you need them to hit because that’s the number you’ve agreed for the MBO or acquisition…

… so your Banker may well work with you to help get the CFADS figure to where it needs to be (see the video above) … hey… your Banker has a target to hit, bonus to earn, and he knows that if he says no you’ll be off somewhere else…

… and bankers hate losing clients

MBO … you know it makes sense

I’m seeing an increasing appetite among bankers to fund an MBO… which is a great thing all round.

Owners get to sell all or part of their holdings and realise value… to people who know the company well and are seriously committed to making sure it survives and thrives

Bankers get to fund a team who know the company warts & all, yet still want to financially hitch themselves to the company wagon for years to come… And if the Bankers funding the deal are the company’s long-time bankers, with a real knowledge of the company and its prospects, so much the better

And there’s more… much more

Not only do seller and funder get what they want (value extracted … chunky low-risk funding)… they get it quick… and I mean quick

High Street bankers can and really do turn an MBO around in less than 2 months.

Think about that.

8 weeks from today you could have sold out… if you’ve a team who’ll buy

Compare that to the market…

I typically tell owners to expect to wait a year for their money if trying to sell in the market… and not to expect any deal to go through… because few do…

A willingness to get the deal done, quickly, by all involved, with minimal-to-no Due Diligence helps cut the time… as does the comfort the bankers get from funding a team who know the business better than any Due Dil team could

CFADS

For the Bankers an MBO is a form of cash lending… they look less for security and more for an ability to repay… and to measure that ability a lot of them lean heavily on the company’s CFADS

I’ve a separate post on CFADS for the seriously interested… but for the passingly-curious it stands for Cash Flow Available for Debt Servicing

Once the Bank have calculated a company’s CFADS they knock off any existing debt repayments the company has… add a margin of cover … and will typically lend up to 3 or 4 times the remaining figure

In the The Real World

Your Company Valuation is irrelevant…

Again… think about that… the Bank works out its willingness and ability to lend you an AMOUNT… no mention of value here...

… so that amount could be for all your shares… or just 70% of them… leaving you with 30% as your team take on the business…

… in fact your Bank would prefer it if you don’t sell out entirely… no whiff of ‘cutting & running’… plus the old owner is still around to help the new owners…

So what’s the catch?

You still need all the deal-making & legals doing right

Heads-of-Terms… an SPA (Share Purchase Agreement)… a Shareholders Agreement… as well as any Service Agreements (e.g. for your new role, and for their new roles)

And the bank will want all the forecasts they can eat…

But none of that stuff should stop the deal happening within 8 weeks from now

Wow

But what about the M in the MBO ?

For Management this will be a big step up… and in the old days it meant lots of  PGs (Personal Guarantees) and some skin in the game (in the form of perhaps one year’s salary)

But the old days are gone… we are in a world awash with cash… and the banks aren’t pushing for skin… and any PGs can be limited to silly low numbers (which the selling owner can guarantee if that helps get the deal done)

Interesting times… 

I’m absolutely convinced there are no meaningful supply side issues when it comes to companies like yours getting funding… it’s the demand that’s lacking…

… and I’m also absolutely convinced the banks keenness for these MBO deals is strongly correlated with this supply / demand mismatch…

… long may it continue…

 

 

Innovate

R&D tax reliefs and grants work … will Patent Box work better?

Innovation is one of the best drivers of growth for an owner managed business… and luckily the Government really does get it… offering some bonkersly brilliant and accessible help that actually works for companies like yours…

As a form of Corporate Welfare (which I’m generally against) these innovation-orientated tax breaks and grants rather surprisingly do what they’re supposed to do… boost productivity and create jobs (which I absolutely love)

Innovate UK are busy getting grant money out to innovative firms… and, as the Enterprise Research Centre recently reported, the range of grants available has made a real impact… Over a 13-year period, R&D grants spurred growth worth £43bn to the British economy – more than five times the £8bn invested – and created around 150,000 jobs

… one helluva an ROI

But R&D Tax Reliefs  are doing even better imo… not only does research suggest this tax saving for SMEs is working financially…  Our current evaluation suggests that for each £1 of tax foregone, between £1.53 and £2.35 of R&D expenditure is stimulated… I believe it is changing the mindset of some of the companies applying…  

What started out as an attempt to justify a claim for a extra tax deductions and get money back from HMRC… is morphing into a mindset shift for the companies involved as they start to genuinely put innovation at the heart of what they do…

And I think the Patent Box could take that shift towards innovation to a completely different level…

The tax relief for having a Patent is now so good that companies I tell about it immediately start to think what they are doing or can do that’ll lead to a narrow patent and get them a 10% Corporation Tax rate for a couple of decades…

Changing minds is surely one of the hardest things for a Government to do… but, because of these innovative tax reliefs, minds really are changing when it comes to innovation

Here’s a couple of older blog posts on the subject…

R&D Relief

First Claim

Patent Box

And a great (if slightly technical) site for keeping up to date with any odd updates to the tax reliefs…

Keeping tabs on changes to reliefs

 

 

 

finance

Finance further up the food chain…

I like to think this blog is for scale-up owner managed businesses… so here’s a few aspects of finance further up the food chain that may be useful to know as your capital requirements change as you grow…

And since I like to give a few ‘insights & angles’ I’d rather not list all the types of finance available… just pull out a few interesting points…

Bullet Loans

Fancy a capital injection where you make no interest payments and no repayments of capital until the end of the loan… say 3 or 5 years later ?

That means you get to use all of the cash to grow your business… and pay absolutely nothing back for 3 to 5 years…

… and even then you can ‘roll it’ into a new loan…

They’re called Bullet Loans… and larger companies can get them from high street banks… so why not you?

I know a big name bank doing Bullet Loans for guys like you… if you’re looking to borrow £500k or more… and it’s one of those things where the more you’re trying to borrow the easier it can be to get

Private Equity

PE investment companies come in all shapes and sizes… with different specialisms and interests… and for me they differ from Venture Capitalists by liking less speculative opportunities…

PE outfits will gravitate towards companies & teams already well on their way who’d like to unload some (or all) of their shares to professional investors who’ll help drive continued growth…

Once you’ve got EBITDA (Operating Profit adjusted for Depreciation) around the £1m mark, picking up interest from PE outfits gets easier… and if you can show a route map to trebling EBITDA in the next 3 years it’ll definitely get them excited…

Venture Debt

I love finance… it’s an incredibly innovative space… full of developing financing options you may not know of… like Venture Debt

While PE houses gravitate to EBITDA producing investment opportunities… Venture Debt providers will be there for zero profit companies… early stage growth companies… and even start-ups…

I include it in this blogpost because you can’t get Venture Debt for just a few grand… it’s serious money for serious growth prospects…

The debt terms can be very flexible… ranging from traditional repayment models to interest only with balloon payments… but it comes with some rights to convert debt into equity so the lenders can become shareholders in the company under certain conditions…

The lender gets traditional security levels (charges over company assets etc) but the extra risk of lending to riskier companies is compensated for by equity warrants (chance to own shares in a growing company)

Personal Guarantees

As you take in more capital the Personal Guarantees you might be asked to make can get a bit big on you…

… you may not mind PGing a £20k overdraft facility… but PGing a £600k loan might make you & those back at home wince…

You can now insure against a PG being called in… and as the PGs get bigger this option may well suit

But if insurance doesn’t appeal… and if the PGs are called in… there are specialist Lawyers who negotiate with the banks for you and drive the amount you have to pay up waaaaay down… often with a no gain/no pain fee structure…

Loans against your shareholding

Rare as rocking-horse poop… but as your company grows and attracts outside investment you may find yourself locked in…

… you can’t sell your shares… can’t earn money outside the business… and your wages etc may be capped…

And to add to the frustration… your shareholding in your company may be your biggest financial asset… but you can’t use it !

Or can you?… there are people out there who’ll let you raise money using your shares as security.

Interesting times for Finance

Even if none of the above works for you…  the point is… different sizes of companies, at different points in their growth cycles have lots of different options…

… and the financial innovation at the moment can seem absolutely dizzying with oodles of new offerings…

… so…

… at the risk of invoking the ‘Chamberlain Curse’… why not make the most of living in interesting times… ?

 

 

R&D Tax Relief

R&D Tax Relief… use it to raise money?

R&D Tax Relief isn’t just a great way to get HMRC to help fund your Research and Development… you can use it to raise money

Already Claiming?

26% of declines by banks are because of affordability… which means your business plan & forecasts haven’t convinced them that you can afford the borrowing you’ve applied for …

So make sure your plan takes into account that you’ll be paying out less in tax every year you’re doing R&D… or even getting money in from HMRC… (because if you make a loss you can surrender your tax relief for cash from HMRC)

I’ve recently seen business plans from two companies that already claim R&D Relief… and will keep on claiming it year in year out… but their forecasts didn’t take that positive ‘cash-flow’ and profit effect into account…

Not Claimed R&D Tax Relief yet?

Why not? HMRC really are keen for you Owner Managed Businesses to do it.

So much so they’ve recently introduced ‘Advanced Assurance’ ...

If you’ve never claimed R&D Tax Relief before… have Turnover less than £2m… and less than 50 employees… you can go online and see if your R&D plans qualify for this cracking tax break…

… and they will give you a written confirmation that your plans will qualify for up to the next 3 years…

… so when you model your cash flow & profit forecasts you can take account of the reduced tax you’ll pay… or the tax that HMRC could actually end up paying you…

… that will make your plan more realistic… and any funding you’re trying to raise will look more affordable…

DIY

Like me, HMRC are aware that a lot of you have accountants / advisors who aren’t working the R&D wrinkle for you… so they’re happy for you to go DIY… take a look… the Advance Assurance is all done online…

 

 

 

 

 

Problems with Personal Guarantees…

Guarantee I don’t like ’em… never have done… and I think they stand in the way of decent companies accessing the external capital they need to grow.

There’s an example of the problems they cause in another post I did : The Problems with Banks… their attitude to security

So why does just about every lender insist on PGs?

I wish I knew…

I suspect it’s because they can.

They’ll claim it’s to take account of the risk involved in lending to an owner managed business… by ‘lifting the corporate veil’… because ‘if the owners aren’t prepared to stand behind their company why should we lend to it’…

BUT

… the interest rate on any borrowing is supposed to reflect the risk of lending…  so the risk premium is baked in… the riskier the company, the higher the rate…

So why don’t lenders let the rate really take the strain and offer borrowers a choice ? … say 4% over base with a PG… 6% over base without… (a ~ 50% premium for the extra risk)

I know which one the growth companies I work with would choose…

Which begs another question…

Where are the genuine innovators in the Fintech space?

Lots of clever people with a lot of smart money busy building sites & offerings… but I don’t see too much innovation… let alone disruption…

Incremental innovation aplenty… but if they want quality companies with growth prospects to take on the external capital that’ll make growth less painful & more fun then the Fintech guys will have to take a punt on being more disruptive… by being more responsive to the needs of their target market…

Say… offering money with have two buttons on the site… choice is a wonderful thing… one PG low-Rate… one no-PG high-Rate… and watch which one gets pressed…

But at the very least all these PG loving lenders should let you know you can get insurance against the chance your PGs will be called in…

PGI Cover from Purbeck covering up to 80% of your PG is available

One of the better-kept secrets…

Again I don’t why…

 

 

 

 

 

The problem with banks… ?

It’s bankers’ outdated obsession with security that’s stopping SMEs borrowing…

A typical owner managed business looking to their business banker for funding will end up being asked for Personal Guarantees to secure any loan… and that’s got to stop

The desperate will always sign whatever the bankers want… but the rest are increasingly turning away from bank finance… and who can blame them…

Last month I was with a solid, established company who have a real growth opportunity. The middle aged owners have run the company profitably & completely debt free for over a decade, and for all that time they’ve been with the same bank… yet they didn’t get the modest business loan they wanted… why?

Because after supplying all the historic accounting information (which their bank had already been given), filling in all the forms, doing a we-all-know-its-useless-but-ya-gotta-do-it forecast, and emailing, phoning, meeting their lovely manager… the bank insisted on full Personal Guarantees for the whole loan…

These people have homes, with mortgages paid off, teenage kids etc … why the hell would they take the business risk so deeply into their personal lives that they could end up homeless at their age & after all their efforts?

Strikes me all the risk was on their side…what real risk were the bank taking when offering a loan that’s more than fully secured?

My gripe is… interest rates charged on loans are supposed to reflect risk… the higher the risk, the higher the rate… so let the rate take more of the strain… and drop the obsession with security

…or let’s be really radical and offer a company 2 rates… a lower one with Personal Guarantees… a higher one without any…

Security : how it works
This obsession with security & personalising a business’ risk is a real problem for the economy as whole (and for a Government that wants you to borrow)

It means banks effectively ignore any drivers of growth within the business (customer base, order book, employee skills, market position), and concentrate far too much on tangible assets to support any lending.

They make that even worse by applying ‘risk weighted asset’ models … which normally means ignoring most of your assets, like Stock or W-i-P.

It also means ignoring Debtors (which is why they try to push you to invoice discounting or factoring… they can’t lend against your Debtors… but they ‘know-a-man-who-can’)

So you’re typically left with tangible Fixed assets… which usually means Property.

For most Owner Managed Businesses this all means they haven’t got enough assets in the business to support the bankers’ obsession for security… so it gets Personal with Guarantees required.

Your manager : how he works
Your bank manager has almost no impact on the situation… they just package up the deal proposal to pass on to a remote credit committee…

That ‘committee’ makes a decision & sets terms based on a few of things, but they will :

1.check your company credit ratings : if you’ve met me you’ll know how important I think ratings are nowadays… banks take these ratings and employ a few twists of their own…

eg typically ‘Head Office’ will rank your sector (often in a traffic light scheme)… and the rankings are always changing…

… so a builder might find it easy to borrow today because construction is ‘green’, but next month it might be ‘red’ as the bank tries to reduce exposure to the sector or have a more balanced loan book… and now the builder won’t get the loan

2.check your bank manager’s record : after years of successfully not losing the bank’s money and only putting to the credit committee deals that they’ll accept, a manager will be given an internal score or % that improves as time passes…

I know an 80%er… and a 95%er…  the 95% banker is as close to ‘can-do-the-deal-guaranteed’  as you’ll get… but just you try getting him to take on a deal that he’s happy to put his name & score to and that he’ll push up to the Credit Committee…

(as an aside this is why sometimes the process can take so long… your manager may be stalling because he knows your current credit rating & sector rating means you’ll get knocked back.. and he doesn’t want to see that happen (it hurts you & his own internal score)… so he may spin things out to see if you or your sector rating improve… and of course they hate to say an outright ‘no’ because then you’ll go elsewhere !)

So what’s to be done?

I work with some cracking bankers… and they do genuinely want to lend and support the SME sector… and the fact that you guys aren’t borrowing is genuinely puzzling them…

So.. assuming that encouraging SMEs to take on more debt is a good thing… how about we :

1. get rid of bankers’ anachronistic reliance on Personal Guarantees
2. reduce their obsession with security & their reliance on ‘risk weighted asset’ models (which struggle to work for younger, service based businesses)
4. let the interest rate alone reflect more of the risk of the loan

And if the interest rate then gets too high… and the Government still wants to interfere with the market to get SMEs borrowing & growing again… they can subsidise the rate & get it down to a better level…

But it’s not interest rates that are the problem… or access to finance in the first place (only 9% claim it’s a barrier according to the SME Monitor, down from 15% 2 years ago)…

It’s the banks, and the terms they demand.

R&D Tax Credits… they want YOU to claim them

… and you don’t need a white coat… or an R&D department

Research & Development tax credits are the Government’s way of encouraging companies to develop new products and services…

Any company that spends money trying to improve a product or service or even a process through a technological advance where there’s doubt about the project’s success is likely to be eligible.

Is that you?

There’s a real good chance it is, and frankly HMRC are desperate for SMEs like you to claim the tax relief, regardless of the sector you operate in.


Some research suggests the largest number of claimants are in construction, and not high tech companies as you might expect.

I personally know of landscape gardners, web companies and very small manufacturers who have been successful in getting actual cash back from the tax man… and they did it all themselves.

How’s it work?

If you’ve spent money on R&D costs such as wages, raw materials & software then you can deduct up to 225% of these costs from your taxable profits. You can go back up to 3 years, and if that means you’ve overpaid tax then HMRC will send you a cheque.

And they send that cheque real quick.

Who does the claiming
Your accountant should be able to do it for you… but often they won’t, and frankly some don’t know how.

‘It’s not for companies in your sector’
‘It’ll mean masses more paperwork’
‘You have to produce a huge technical report.’
‘It will probably spark a tax investigation from HMRC’

Just some of the things accountants have told companies I know… so I told those companies to call HMRC directly and do it themselves… and they were all successful in getting the reliefs… without their accountant’s help… or fees.

A word on consultants & what will they cost?

There are some very good ‘no gain, no pain’ consultancy firms who will help you claim the tax relief. That means no payment unless they get you some tax money back.

Personally I know Terry Toms at RandDtax.co.uk… and they do a great job… taking 18% of the money recovered

There are others (eg Jumpstart ) and terms differ so it’s worth checking just what you’ll be paying out if successful (& for how long… I’ve heard of one that takes a cut for the next 4 years too… which is a touch too generous!)

Your first Claim

Have a poke around the HMRC website. See if you roughly match the basic criteria. Then give them a call. They really are very friendly and helpful … at least when it comes to R&D tax reliefs!

HMRC’s eligibility criteria can look daunting (there are links below)… but it’s not

Try asking yourself these questions :

Technology : Does my company attempt to develop new technology, with no guarantee of success?

Improvement : Does my company try to make objective, measurable, and significant improvements to the design and implementation of its products, services or processes?

Problem solving  : Does my company use appropriately qualified or experienced internal staff to solve a challenging technical problem (although you can use sub-contractor for parts of the project)?


Here’s the way HMRC frame those questions… this is an email from an HMRC R&D tax relief officer…
1 What is the scientific or technological advance?
Rather than stating the name of the product, process, functionality, etc, being developed you should consider what scientific or technological advance is being sought. This focuses attention on the project’s aim for an advance, which is the key issue in judging whether R&D for tax purposes is being undertaken.
Science does not include work in the arts, humanities and social sciences (including economics).
It’s not enough that a product is commercially innovative. You can’t claim in respect of projects to develop innovative business products or services that don’t incorporate any advance in science or technology.
2 What were the scientific or technological uncertainties involved in the project?
Scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice, is not readily available or deducible by a competent professional working in the field.
But uncertainties that can be resolved through relatively brief discussions with peers are routine uncertainties rather than technological uncertainties. Technical problems that have been overcome in previous projects on similar systems are not likely to be technological uncertainties.
You should set out at a high level, in a form understandable to the non-expert, what these uncertainties were and when they started and ended.
3 How and when were the uncertainties actually overcome?
Describe the methods adopted to overcome the uncertainties and the investigations and analysis undertaken. This should not be in great detail, simply sufficient to show that the matter was not straightforward. Describe the successes and failures and the impact of these on the overall project. If the uncertainties were not overcome, explain what happened.
4 Why was the knowledge being sought not readily deducible by a competent professional?
It might be publicly known that others have attempted to resolve the uncertainties and failed, or perhaps that others have resolved the uncertainties but that precisely how it was done is not in the public domain. In either case a valid technological uncertainty can still exist.
Alternatively, if the project is one where there is little public information available, you’ll need to show that the persons leading the R&D project are themselves competent professionals working in the relevant field. This might be done by outlining their relevant background, professional qualifications and recent experience. Then have them explain why they consider the uncertainties are scientific or technological uncertainties rather than routine uncertainties.
Whichever is appropriate set out the details and have evidence available if needed.